MANUFACTURING PMIs

USA: Renewed expansions in output and new orders as cost pressures soften

Operating conditions across the US manufacturing sector remained relatively subdued in September, according to latest PMI^TM data from S&P Global. Although output and new orders returned to growth during the month, rates of expansion were historically muted. Nonetheless, firms expanded their workforce numbers at the fastest pace since March, although labor shortages continued to hamper firms’ ability to work through incoming new orders. Outstanding business rose again and at a quicker rate. Concerns regarding inflation and client purchasing power weighed on expectations, which dipped from August, and input buying.

At the same time, cost pressures softened amid reports of lower prices for some inputs. Although slower than those seen earlier in the year, the rate of selling price inflation picked up slightly as firms continued to pass-through higher cost burdens to customers.

The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index™ (PMI™) posted 52.0 in September, up from 51.5 in August and broadly in line with the earlier release ‘flash’ estimate of 51.8.The headline index was above the 50.0 neutral mark, as has been the case for the last 27 months, but continued to signal muted improvements in the health of the manufacturing sector.

The slight uptick in the headline reading was supported by renewed expansions in output and new orders at the end of the third quarter. Greater production was linked to increased client demand. The rate of growth was the quickest since May despite being slower than the series trend and only marginal.

New orders rose for the first time for four months in September, albeit at only a mild pace. Companies noted the acquisition of new customers and an improvement in demand conditions. The rate of expansion was much slower than those seen earlier in the year, however, and well below the series trend amid cost-cutting efforts at clients.

At the same time, new export orders fell further as challenging economic conditions and a strong US dollar weighed on foreign customer demand.

On the price front, input costs rose at a slower pace in September. The rate of inflation was still historically elevated amid reports of hikes in energy and material costs, but eased to the softest since January 2021 as inputs such as steel, plastics and lumber reportedly fell in price.

In an effort to drive sales, manufacturers registered a softer increase in selling prices compared to earlier in the year. That said, the pace of charge inflation ticked up from August as firms sought to pass through higher cost burdens to clients.

Supporting the softening of cost pressures was the least marked deterioration in vendor performance for two years at the end of the third quarter. Reports of greater input availability and less severe transportation delays contributed to greater supply chain stability.

Nonetheless, input buying fell at a quicker pace and preproduction inventories were depleted for the first time since February 2021. Stocks of finished items increased marginally as some firms noted lower than expected new order inflows.

Meanwhile, employment rose at the sharpest pace since March in September. Labor shortages were nonetheless evident, leading to another rise in backlogs of work, as firms stated that job creation stemmed from greater production requirements.

Manufacturing firms remained positive on balance regarding the year ahead outlook, but the degree of confidence dipped from August. Concerns surrounding inflation and client purchasing power weighed on sentiment which was below the series trend.

The ISM:

The September Manufacturing PMI registered 50.9 percent, 1.9 percentage points lower than the 52.8 percent recorded in August. (…) the September index reading reflects companies adjusting to potential future lower demand. The New Orders Index returned to contraction territory at 47.1 percent, 4.2 percentage points lower than the 51.3 percent recorded in August. (…) After a single month of expansion, the Employment Index contracted at 48.7 percent, 5.5 percentage points lower than the 54.2 percent recorded in August. The New Export Orders Index contracted at 47.8 percent, down 1.6 percentage points compared to August’s figure of 49.4 percent. This is the index’s lowest reading since June 2020, when it registered 47.6 percent.

WHAT RESPONDENTS ARE SAYING

• “Concerns of global economic slowdown are growing, and (we are) experiencing some customers pulling back orders.” [Chemical Products]
• “Production is steady, allowing reduction of backlog amidst slightly softened demand.” [Transportation Equipment]
• “Almost all suppliers are experiencing lead times growth. It seems no one wants to keep inventory on hand anymore.” [Food, Beverage & Tobacco Products]
• “Business is flat to down due to inflation and interest rates. Hard to find and keep employees due to wage increases by competitors.” [Fabricated Metal Products]
• “Supply chain constraints on many items are still an issue; staffing on the production side continues to be a significant problem. In contrast, we have more stock than needed on some key items — specifically imports — and have begun reducing open purchase orders and decreasing extended forecasts on those items in order to bleed down inventory.” [Machinery]
• “Business continues to be strong. Some commodities within the supply chain are starting to stabilize, while others are still causing disruption for production. Electrical and wiring components continue to cause significant issues. (We) cannot run as consistently as we would like.” [Electrical Equipment, Appliances & Components]
• “Quotes and orders still strong; however, we are not able to accept any new orders for shipment (for the rest of) 2022 due to motor and electronic component shortages.” [Miscellaneous Manufacturing]
• “The supply chain is still stressed, and it challenges our manufacturing plants for uptime. We have strong demand and need to run.” [Nonmetallic Mineral Products]
• “Business is still strong; raw materials are becoming more available, and some raw materials prices are falling.” [Plastics & Rubber Products]

The two surveys are coming back more in line, indicating subdued and spotty growth in demand and employment.

• The Goldman Sachs Analyst Index, which includes service as well as manufacturing industries, tallies GS analysts about their assessments of their respective industries: “The shipments component declined substantially, the new orders component declined into contractionary territory, and the exports component declined to its lowest level since June 2020, while the employment and wages components both increased. (…) 45% of surveyed analysts indicated that higher labor costs were the main driver of price increases so far in 2022, while around 40% indicated higher input costs and roughly 5% indicated higher margins.”

Eurozone: Manufacturing sector downturn accelerates in September as demand tumbles further and price pressures intensify

Excluding the initial pandemic lockdowns, eurozone manufacturers have not seen a collapse of demand and production on this scale since the height of the global financial crisis in early-2009. Worse looks set to come, with orders slumping at a significantly steeper rate than production is being cut. Further steep production cuts look to be on the cards in the coming months unless demand revives.

The euro area’s manufacturing sector fell deeper into contraction territory during September, latest PMI® data from S&P Global showed, due to further slides in both output and new orders. In some cases, production volumes were reduced in response to high energy prices, while many firms downwardly adjusted their operating schedules in line with lower order books. Demand for eurozone goods sank sharply in September as high inflation and economic uncertainty reportedly squeezed client appetite. Business confidence subsequently fell to its lowest level since May 2020, leading firms to cut purchasing activity further in anticipation of more challenging conditions.

Meanwhile, inflationary pressures accelerated in September. Although pressures arising from material shortages had reportedly faded slightly, many companies remarked on the rising costs for energy.

The S&P Global Eurozone Manufacturing PMI® fell to 48.4 in September, from 49.6 in August, signalling a further worsening of operating conditions for euro area goods producers. Moreover, the headline index slumped to its lowest level since June 2020.

Ireland was the only monitored euro area country to record a manufacturing PMI in expansion territory during September. France and Germany – the two largest eurozone economies – both recorded the worst deteriorations in manufacturing sector conditions at the end of the third quarter, with their respective PMIs at the lowest levels since the first wave of the COVID-19 pandemic in the first half of 2020.

For a fourth successive month, manufacturing output levels fell across the euro area. The reduction was solid overall and of a similar strength to that seen in August. Lower production was primarily a consequence of fading demand, according to panellists, although others commented on the adverse impact of ongoing supply shortages. In some cases, factory output was restricted as some firms looked to curb energy usage amid soaring prices.

The downturn in manufacturing new orders continued in September and accelerated from the previous month. Overall, the decrease in demand was the sharpest since May 2020 and reflected a broad weakening of client appetite. High prices reportedly deterred customer purchases, although other companies commented on the adverse impact from economic uncertainty.

With the rate of contraction in new orders exceeding that for output, euro area manufacturers were able to make inroads into their backlogs during September. In fact, the level of work outstanding fell at the quickest rate in over two years. Employment growth continued nonetheless, but slipped to its weakest since February 2021.

In a further sign of distress, eurozone manufacturers reduced their purchases of inputs for a third month and to the quickest extent since June 2020. This was in response to lower output requirements, and as part of efforts to prevent overstocked warehouses. Indeed, pre-production inventories rose once again in September despite the sustained drop in buying activity. According to firms, this reflected improving raw material availability, although others mentioned an unintentional expansion due to poor sales.

Meanwhile, supplier delivery delays were at their least widespread for almost two years in September as improved raw material availability and a drop in demand helped ease pressures on vendors.

Nevertheless, rates of input cost and output price inflation accelerated in September, the first time since April this has been the case. According to panellists, soaring energy prices were a key factor behind the intensification of cost pressures. In turn, factories passed on higher expenses to their clients through stronger increases in selling charges.

Lastly, the level of business confidence slipped back into negative territory in September. In fact, euro area manufacturers were at their most pessimistic since May 2020. Survey respondents attributed their downbeat assessment of the year ahead to soaring energy costs, the ongoing war in Ukraine and fears of a recession.

Top Fed Official Warns of More Persistent Price Pressures ‘Tighter monetary policy has begun to cool demand and reduce inflationary pressures, but our job is not yet done,’ said New York Fed President John Williams

Despite some signs of easing inflation, underlying price pressures have too much momentum and will likely require a period of higher interest rates, a top Federal Reserve official said Monday. (…)

Mr. Williams compared inflation to an onion, with the prices of globally traded commodities such as lumber, steel, and oil, serving as the outer layer, and durable goods such as appliances, cars, and furniture serving as a middle layer. Declining commodities prices and improving supply chains should slow inflation for many goods, Mr. Williams said.

“Unfortunately, that’s it for the good news on inflation,” he said. “The fact is, lower commodity prices and receding supply-chain issues will not be enough by themselves to bring inflation back to our 2% objective.” (…)

“Therein lies our biggest challenge…. Inflation pressures have become broad based across a wide range of goods and services,” Mr. Williams said. “Demand for labor and services is far outstripping available supply. This is resulting in broad-based inflation, which will take longer to bring down.” (…)

S&P Global’s findings do not point to much goods deflation just yet:

Although the latest price and supply indicators from S&P Global continued to point to relatively mild cost pressures across the global manufacturing sector during September, reports of price rises were up compared to August and were slightly above the long-run trend. Greater energy costs were a key driver of this, with reports of higher energy prices running at over 14 times the normal level as the war in Ukraine continued to impact energy markets. Increased semiconductor prices were also cited as a key source of inflationary pressure.

There were further signs of supply chain pressures easing,
however, with total supplier shortages at their least severe for nearly two years. Nevertheless, only 11 out of 20 raw material categories noted a reduction in supplier shortfalls, as shortages worsened for key materials such as oil, copper and semiconductors.

Vehicles Sales Increased to 13.49 million SAAR in September Wards Auto estimates sales of 13.49 million SAAR in September 2022, up 2.3% from the August sales rate, and up 9.8% from September 2021.

• That Covid Goods Boom is Going Bust, Bloomberg Trade Tracker Shows You can see the suffering illustrated on the Bloomberg Trade Tracker, where several of the 10 primary gauges floated in “below normal” range at the start of October and none looked good relative to their long-run averages.

2%+ Starts to a Quarter: A Baker’s Dozen

(…) The last time the index kicked off a quarter with a 2%+ gain was in Q1 of 2013, and the last time it started Q4 with a 2%+ advance was 19 years ago in 2003.  If the S&P 500 manages to hold onto its current gains, it would be just the 6th such gain of 3%+ to kick off a quarter since 1953. (…)

Of the twelve different 2%+ rallies highlighted, the S&P 500 rallied an average of an additional 2.1% (median: 2.5%) for the rest of the quarter with gains two-thirds of the time.  Of those twelve different occurrences, though, the range of returns varied widely with the best rest-of-quarter performance being a gain of 18.7% (Q1 1975) while the largest rest-of-quarter decline was 14.4% in Q1 2009. 

At the bottom of the table, we also show the average ‘rest of quarter’ returns after the first day of trading for all quarters since 1953.  With an average gain of 2.0% (median: 2.7%) and gains 66.5%, the returns are nearly the same as returns following strong starts to the quarter.  In other words, based on the results following the 12 prior occurrences, a strong start to the quarter tells you very little about the rest of the quarter’s performance. Click here to learn more about Bespoke’s premium stock market research service.

U.S. Seeks to Further Restrict Chip Exports to China The Biden administration’s action is aimed at preventing China from making high-end semiconductors, sources say.

The Biden administration is preparing new export controls on semiconductors and the machines to make them, the latest push in its effort to deny China the ability to make the fastest, most cutting-edge circuitry possible, according to people familiar with the situation.

The administration in recent weeks has already placed new restrictions on some U.S. exports of chips used for artificial-intelligence calculations and manufacturing equipment used to make some of the most powerful number-crunching chips.

But more export curbs are under consideration, including ones targeting high-end memory-chip manufacturing capabilities and advanced components that go into some of the most cutting-edge chip-making tools, according to the people familiar with the matter. Advanced quantum computing is another target under discussion, they said. (…)

Many of the expected actions the Biden administration is set to announce are likely to expand restrictions that it already has taken against individual companies, by making them apply industrywide, according to one of the people familiar with the situation.

For example, Nvidia Corp. disclosed in August that it could lose as much as $400 million in quarterly sales after the U.S. imposed new licensing requirements on shipments of some of its most advanced chips to China. The U.S. imposed the requirement to address the risk that the products could reach the hands of military users, Nvidia said.

Kim Kardashian Pays $1.26 Million to Settle SEC Probe The entrepreneur and reality-TV star failed to disclose compensation received for promoting EMAX tokens, the SEC said.

Axios explains:

Kim Kardashian was fined $1.26 million yesterday for touting crypto schemes — even as much more high-profile pitches from the likes of Matt Damon and Larry David have gone unpunished. The seeming double standard is a function of a subtle yet crucial distinction in securities law, Axios’ Felix Salmon writes.

Celebrity crypto endorsements drew millions of Americans into the crypto market at the beginning of this year, just before prices cratered. (…)

Legally speaking, it’s fine for celebrities and influencers to endorse investment opportunities, including crypto investments. Where Kardashian crossed the line was when she endorsed a crypto asset security.

• The height of the crypto advertising boom was the 2022 Super Bowl, where companies like FTX and Crypto.com spent untold millions touting their websites as a place to buy crypto — and, implicitly, to get rich doing so.
• Kardashian’s relatively low-budget 2021 Instagram post, by contrast — she was paid just $250,000 for it — touted a specific coin, EthereumMax, that the SEC has determined qualifies as a security. That brings it under SEC jurisdiction, which is much stricter than the FTC regulations governing most advertising.

If you’re endorsing a company, the only rules that apply are the relatively lax ones from the FTC.

• If you’re shilling a security, then disclosing that you were paid — as Kardashian did with an #AD hashtag — is not enough; you also need to disclose how much you were paid.

Consumers Boosted Spending in August U.S. consumers are digging deeper into their wallets to cover rising costs of essentials such as rent and utilities as inflation spreads.

Another rather poor (biased) account from the WSJ:

Household spending rose by a solid 0.4% in August after dropping a revised 0.2% in July, the Commerce Department said Friday. The August increase was just 0.1% after accounting for inflation.

The personal-consumption expenditures price index rose 6.2% year-over-year in August, down from a 6.4% in July, according to Friday’s report. On a monthly basis the index rose 0.3%, up from a 0.1% decline the prior month.

But the core PCE-price index, which strips out volatile food and energy categories, accelerated on both an annual and monthly basis, rising 4.9% in August from a year ago, compared with a 4.7% increase in July, and 0.6% from the prior month.

Spending on services such as rent, utilities, transportation and healthcare picked up strongly in August, and goods spending declined for the second month in a row as gasoline prices fell. (…)

Revised figures on saving habits in recent months showed households’ financial buffers—boosted by stimulus and limited opportunities to spend earlier in the Covid-19 pandemic—have recently dropped more substantially as consumers dip into savings to pay for everyday items.

The personal saving rate was 3.5% in August for the second month in a row, up from a recent low of 3% in June. That was down from 9.5% a year ago and close to levels last seen during the 2007-2009 recession. (…)

In truth, there was nothing solid in this Income and Outlays report:

• Wages and Salaries rose 0.3% in August, half the average rate of the previous 6 months.
• Growth in nominal personal income slowed from 6.1% annualized in Q2 to 3.6% in July/August.
• Real disposable income has declined in 10 of the last 13 months. It is down 4.5% YoY and 0.9% below its pre-pandemic level. It is up only 0.7% annualized in the last 5 months.
• Unsurprisingly, real expenditures are slowing down rapidly: Q1: +3.2% a.r.; Q2: +1.7%; July/August: +0.2% a.r. using all available decimals. July was revised down from +0.2% to -0.1%.
• The savings rate was unchanged at 3.5% in August but up from 3.0% in June. It was 8.7% in Q4’19. Accounting for inflation, the level of personal savings is 63% lower than before the pandemic.
• Real expenditures on Goods continued to decline: -0.2% MoM in August. They are down 3.5% a.r. since February.
• This past week, CarMax Inc. shares sank after the used-car retailer flagged that high prices, paired with high broader inflation and rising interest rates, have slowed demand. The company’s profit fell 50% in its most recent quarter and its sales leveled off at 2% growth, both worse than analysts expected. “This points to some deterioration in per unit pricing and profitability in the coming quarters, as rising interest rates and economic conditions affect demand,” said Thomas King, president of the data and analytics division at J.D. Power. (WSJ)
• Real expenditures on Services are not taking the slack: they rose 0.2% MoM in August after 0.0% in July. They had increased 4.4% a.r. in Q1 and 3.8% in Q2.
• Last, but not least, core PCE inflation jumped 0.6% in August after being unchanged in July. It is up 4.9% YoY. Inflation on Goods was -0.3% MoM (+8.6% YoY) thanks to lower gas prices. Durable Goods prices were up 0.5% (+5.3% YoY) after declining 0.2% in July. The cost of Services rose 0.6% (+5.0% YoY).

Bank of America’s consumer spending in hardline categories per its credit card tracking through Sept. 24: “We observe a softening trend in most hardline categories on a YoY basis. (…) discretionary demand remained pressured.” (via @MikeZaccardi)

Americans’ propensity to spend is being severely challenged by rapidly slowing nominal income growth, inflation and real personal savings at the 2008 level. Good luck during the holidays season.

• Higher Rates Will Put the Kibosh on Consumption Growth There was nothing in Friday’s report to give pause to the Fed’s plans to keep pushing rates higher. Futures market implied odds of Fed policy makers raising rates by another three-quarters of a point at their meeting in early November, rather than a half point, increased after Friday’s report. (…)

• Goldman Sachs’ baseline forecast calls for the Fed to deliver a 75bp rate hike in November, a 50bp hike in December, and a 25bp hike in February, for a peak rate of 4.5-4.75%. GS has 4 scenarios: “In a non-recession outcome, we see the Fed as most likely to follow roughly our baseline path (30% subjective odds), but we also see a meaningful risk of an upside scenario in which the Fed hikes more than we expect (20%). In a recession outcome, we see the Fed as most likely to cut substantially (30%), but we could imagine more limited cuts if inflation proved stickier in a downturn than we would expect (20%).”

Home Builders Offer to Sell Homes in Bulk at Discount to Investors As mortgage rates hit a 15-year high and individual buyers back away, builders look to unload both planned and completed homes

(…) There were 14% more homes under construction this August than there were a year ago when the sales market was more robust, according to U.S. Census Bureau figures. Major home builders, including Lennar Corp. and KB Home, have reported walking away from contracts to buy thousands of lots for future building projects. (…)

Dean Myerow, co-founder of Fort Lauderdale, Fla., rental owner and developer Southern Waters Capital, said he is in contract to buy 20 new homes a month from a builder in Florida. The builder’s retail business has dried up in recent months amid higher interest rates, Mr. Myerow said. He estimated the discount to retail he will receive on the homes is between 15% and 20%.

“We think rental rates will remain very strong,” he said. (…)

Buying homes in bulk next to each other instead of scattered is easier to manage, investors said. (…)

OPEC+ to Weigh Production Cut to Bolster Oil Prices The group is considering an output reduction of 1 million barrels a day, its biggest cut since the pandemic began, as the economic slowdown hurts demand.

• Oil Output Cut Will Underwhelm Without a Big Change An OPEC+ output cut will be diluted by its members’ chronic underperformance — unless baselines are changed or Saudi Arabia acts alone.

(…) OPEC+ can’t keep things as they are and retain credibility. The amount the group pumps and its theoretical target have become increasingly estranged from each other over the course of the year, with output lagging behind the planned volume by more than 3.5 million barrels a day in August, according to figures compiled by Bloomberg.

That big gap is going to dilute the effects of any cut decided on Wednesday, unless they can agree to redistribute targets among themselves to reflect the inability of most members to pump as much as they’re allowed.

Even a reduction of 1 million barrels a day, shared pro rata among the members, would require just six countries to make actual cuts. All the rest are pumping so far below their individual targets that a step-down would have no impact. The resulting reduction would be just 337,000 barrels a day — and that’s assuming, perhaps optimistically, that all six stick to the plan.

A contraction of 500,000 barrels a day would see just five countries needing to pump less and would deliver shrinkage in actual supply of just 126,000 barrels a day.

Any reduction will come a month before European Union sanctions on Russian crude exports come into effect on Dec. 5, complicating the outlook. Russia is a powerful and valued member of OPEC+, so despite the group’s self-declared role of balancing oil supply and demand, don’t expect other members to rally round and make up for any shortfall in global availability resulting from the EU embargo.

Seaborne crude shipments to Europe from Russia are currently running at about 820,000 barrels a day, but the sanctions could hit wider flows, with the EU also set to ban the provision of insurance and other services to tankers carrying Russian crude, no matter where they’re headed.

(…) [Saudi Arabia] can always make another of its voluntary additional cutbacks. With production now running at about 11 million barrels a day, the kingdom could certainly afford to trim output, and some of its oil infrastructure might benefit from a rest. (…)

The fact that ministers have agreed to meet face to face suggests something more meaningful than a pro-rata cut in output targets is on the table.

U.K. Makes Major U-Turn on Tax Cuts Treasury chief, Kwasi Kwarteng, ditched a plan to cut the 45% top rate of income tax, scrapping a key economic policy after turmoil in the country’s financial markets, an intervention by the Bank of England and the threat of large scale rebellion by Conservative Party lawmakers.

China Property Stocks, Bonds Rally After Report of $85 Billion Lifeline

(…) The buying spree comes after the People’s Bank of China and the China Banking and Insurance Regulatory Commission told the six largest banks to each offer at least 100 billion yuan ($14.1 billion) of financing support, including mortgages, loans to developers and purchases of their bonds, people familiar with the matter told Bloomberg News. (…)

Some doubt whether the measures announced so far will be sufficient enough to reverse the property slump.  

The funding news is in line with policies announced via various regulators in the past six to nine months to support the sector, according to Zhi Wei Feng, a senior analyst at Loomis Sayles Investments Asia. “The intention is good, but the effectiveness is uncertain as the market is getting from bad to worse since the beginning of 2022 and there is no sign of any recovery.” (…)

Fed Rate Hikes Are Pushing Credit Market Toward Dysfunction, Bank of America Says

(…) Leveraged finance markets are reeling this week after the Fed’s latest rate hike in its aggressive campaign to tame inflation. US junk bonds are headed for worst year-to-date losses on record, while banks were forced to shelve a buyout deal in the leveraged loan market after struggling to attract demand from investors.

Investors fled risky assets over fears of a recession, pulling $3 billion from high-yield bonds and $1.9 billion from leveraged loans in the week ended Sept. 28, according to data from Refinitiv Lipper.

Spreads in the high-yield market could rise to around 600 to 650 basis points if the Fed continues with its pace of rate hikes, said BofA. Average high-yield spreads stand at 561 basis points on Friday, according to Bloomberg data.

• Bank CDS pricing also ticking up

(@topdowncharts)

John Authers: As of the end of August, the global central bank rate climbed to 2.97% based on NDR’s calculation, the highest level in the post-Global Financial Crisis period though well below the roughly 5% peak seen in 2001 and 2007. For now, the rate is simply mildly restrictive for global growth; but given the 4.00% expectation by early next year, NDR suggests things might take a turn for the worse.

This would put the rate in the most restrictive mode for the global economy, increasing the risk of severe global recession. As we’ve noted numerous times in the past, severe recessions are usually associated with more pronounced equity bear markets. 

A $1 Trillion Burden Looms for World Borrowers Refinancing Debt Governments and companies around the world are facing unprecedented costs to refinance bonds, a burden that’s set to deepen fissures in debt markets and expose more vulnerabilities among weaker borrowers.

A corporate treasurer or finance minister looking to issue new notes now would likely have to pay interest that’s about 156 basis points higher on average than the coupons on existing securities, after that gap surged to a record in recent days. That all adds up to about $1.01 trillion in additional costs if all those securities were refinanced, according to calculations using a Bloomberg index tracking some $65 trillion of government and corporate debt across currencies. (…)

Concerns are also growing that liquidity is draining out of the world financial system as interest-rate swaps — one of the world’s deepest markets — fluctuate wildly. The gap between the floating- and fixed-rate legs of longer-dated swaps tied to the US Secured Overnight Financing Rate swung in some recent days by the most on record for the index, which was rolled out in October 2020 as a replacement for the London interbank offered rate.

Six US-based borrowers tracked by S&P Global Ratings defaulted in August, as signs mount that higher rates are already taking a toll on stretched borrowers’ ability to keep issuing new debt to pay off old. (…)

Steps by speculative-grade companies to push out debt maturities when markets were favorable should prevent a sharp rise in global corporate defaults, according to a September report by Moody’s Investors Service. The 12-month trailing global speculative-corporate default rate was 2.3% in August and will rise to 3.8% by August 2023 in a baseline scenario, which is still below historical averages. In more pessimistic scenarios laid out in the report, the default rate could rise much more. (…)

It’s not only interest rates. Liquidity’s tanking!

The following chart shows an exercise by Hartnett at BofA to sum changes in central banks’ balance sheets across the world. On this basis, the tightening pressure is on a scale never before seen:

Credit Suisse Shares Fall on Financial-Health Concerns The Swiss bank’s shares fell a day after it tried to assuage fears about its health in a memo to employees and phone calls to investors and clients.

John Authers in Bloomberg:

The economy is not as yet giving the Fed a compelling case to stop hiking, let alone pivot. But there is another outcome that might force a reversal: a financial crisis. (…)

It’s never healthy when a CEO has to offer reassurance like this. But it’s certainly true that the day-to-day stock price performance implies great concern. (…)

Deutsche Bank and Credit Suisse are both now trading at less than 25% of their book value, but Credit Suisse has set a new low (unlike Deutsche), and for the first time since before 2008 now has lower book multiple (…).

Credit Suisse’s CDS has risen to levels to match anything that hit it in the post-Lehman era, and it now far exceeds the implicit default risk of UBS. Debt and share prices like this only make sense if these is a significant move in both the equity and credit markets to position for the risk of a default by Credit Suisse. Any such event would open the possibility of Lehman-style damage (…).

In my opinion, the scenario of a bankruptcy would be so damaging that it could not be allowed to happen; a bailout that marks another huge reverse for tighter money, however, is conceivable. A scenario in which the authorities decide that their best policy is allowing inflation to inflate the banks’ problems away could yet happen, and it wouldn’t be pretty. (…)

Morgan Stanley Says Likely Fed Pivot Won’t End Earnings Pain

Michael J. Wilson, one of Wall Street’s biggest equity bears, says a Federal Reserve pivot to dovishness is becoming likely amid falling money supply, but such a move won’t allay concerns about earnings.

“We find M2 growth in what we call the ‘danger zone’ -– the area where financial/economic accidents tend to occur,” Wilson, Morgan Stanley’s chief US equity strategist, wrote in a note on Sunday, referring to the Fed’s broadest measure for money supply. (…)

Wilson, who predicted this year’s equities selloff, wrote that the year-on-year rate of change in money supply in dollars for the US, China, the Eurozone and Japan has turned negative for the first time since March 2015, a period that immediately preceded a global manufacturing recession. Such tightness is unsustainable “and the problem can be fixed by the Fed, if it so chooses,” he wrote.

The strategist said last week that US equities are in the “final stages” of a bear market and could stage a rally in the near term going into the earnings season before selling off again.

Wilson has said that he sees an eventual low for the S&P 500 coming later this year, or early next, at the 3,000 to 3,400 point level. That implies a drop of as much as 16% from Friday’s close.

BoA’s Mike Harnett also sees a forced pivot: “we are tactical bears…“short twos & spoos” ‘til Halloween…SPX 3333 to force “policy panic” (Nov 16th G20), then rally; “Big Low” not ‘til Q1 when recession/credit shocks = “peak Fed”, “peak yields”, “peak US$”; trade of ‘23 short $, long EM, small cap, cyclicals.”

Hartnett has caught every move perfectly. His reasoning regarding the oversold entry level is basically buying some 20% below the 200 day moving average: currently at 3374. This has worked over the past century (except 1931/37/74 and 2008). He adds: “…monster undershoot requires monster credit event & recession”. (via ZeroHedge)

Runaway Bear Market Blows Past Everything Meant to Slow It Down

(…) Bulls still point to signals that the bottom could be nigh, yet the pattern of past market cycles suggests the pain for American equities can easily persist.

Take a simple accounting of prior bear markets, where the average selloff hit 39% over 20 months. That would imply another 19% drop from here. Or look at how past tightenings have coincided with stock moves. While not all Fed hiking cycles spelled doom for equities, those that did typically failed to find a floor until the central bank reversed its course — a prospect no one on Wall Street can take seriously anytime soon until price pressures subside.

“Inflation is a major constraint because any attempt to rescue markets or international financial stability issues are likely to be inflationary,” said Steve Chiavarone, senior portfolio manager at Federated Hermes. “The market is forced to reckon with the possibility that the central-bank put is not in place.” (…)

Amid the relentless selling, bulls are yielding one after another. Retail traders, one of the most steadfast dip buyers since the 2020 pandemic crash, are bailing on stocks.

JPMorgan Chase & Co. strategist Marko Kolanovic is the latest to succumb to the gloom, citing the risk of policy errors at central banks and an escalation of war following the destruction of the Nord Stream pipelines in Europe.

“The most recent increase of geopolitical and monetary policy risks puts our 2022 price targets at risk,” Kolanovic wrote in a note Friday. “While we remain above-consensus positive, these targets may not be realized until 2023 or when the above risks ease.”

The firm’s year-end target for the S&P 500 is 4,800, a 34% gain from Friday’s close. (…)

During the previous six bear markets, all bottoms formed when the Fed was lowering rates. That’s a long way off considering bond traders currently don’t expect Fed rates to peak until April 2023. (…)

SENTIMENT WATCH

Goldman Sachs:

Hedge funds, mutual funds, and retail traders have slashed equity exposures YTD. However, investor equity positions remain elevated vs. a longer-term history and we forecast further selling in 2023.

Since the start of 2020, households have been the largest source of equity demand, buying $1.2 trillion in equities. However, household demand turned slightly negative in 2Q. Higher frequency mutual fund and ETF flow data also show evidence of slowing demand in recent weeks (see pg. 23). This selling in combination with falling equity prices has led to a sharp drop in household equity allocations (Exhibit 5).

The sharp decline in margin balances over the last 12 months is one indication that retail traders have been largely washed out of the market this year as the fast growing and speculative stocks that they favor have suffered alongside rising interest rates. Our Retail Favorites basket (GSXURFAV) has lagged the S&P 500 by 18 pp YTD.

Both hedge funds and mutual funds remain highly exposed to equities relative to the past decade. Similarly, household equity allocations stand at the 96th%-ilesince WWII, indicating further room to cut exposure should the macro environment continue to deteriorate.

Not quite there yet:

VALUATION WATCH

My June 21 Desperately Seeking The Low remains valid:

• The worst case is 2700-2900 if a crisis or stagflation.
• The Rule of 20 Fair value is in the 3300-3500 range.
• Watch inflation and the Fed, particularly if the economy slows measurably. Slower inflation might bring the doves back and a good buying opportunity along.
• Using Price/Book and ROE: 3250-3375.
• All in all, current fair value falls in the 3300-3500 range. But watch inflation…and the Fed.

As of Friday’s close:

• The S&P 500 median trailing P/E is now 17.2 (17.7 last week, 18.7 two weeks ago). On forward: 15.1 (15.7 and 16.8).
• The 6 largest stocks by weight (21.4% of the index) have an average P/E of 45.8 (47.0 and 50.2). On forward: 29.0 (29.9 last week).
• 41% of the companies have a P/E below 15.0 (39% and 37%. On forward: 49% (48%).
• 21.6% (19.6% and 16%) are below 10x. On forward: 22.2% (20.0%).

Factset:

During the third quarter, analysts lowered EPS estimates for the quarter by a larger margin than average. The Q3 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for Q3 for all the companies in the index) decreased by 6.6% (to $55.51 from $59.44) from June 30 to September 29.

In a typical quarter, analysts usually reduce earnings estimates during the quarter. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 2.3%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 3.3%. During the past fifteen years, (60 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 4.8%. During the past 20 years (80 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 3.8%.

Thus, the decline in the bottom-up EPS estimate recorded during the third quarter was larger than the 5-year average, the 10-year average, the 15-year average, and the 20-year average. The third quarter also marked the largest decrease in the bottom-up EPS estimate during a quarter since Q2 2020 (-37.0%).

While analysts were decreasing EPS estimates in aggregate for the third quarter, they were also decreasing EPS estimates in aggregate for the fourth quarter. The bottom-up EPS estimate for the fourth quarter declined by 4.5% (to $58.01 from $60.73) from June 30 to September 29. 

In addition, analysts lowered earnings estimates for CY 2023 during this time, as the bottom-up EPS estimate for CY 2023 decreased by 3.5% (to $241.83 from $250.60) from June 30 to September 29.

PLAYING THE ODDS GAME?

Stats and charts are invading the blogosphere, to suggest the lows are near or lower or further out. (Via Callum Thomas)

@MacroAlf

• The 24-month Williams%R Oscillator is showing up increasingly extreme oversold…albeit, the early-2000’s shows how the market can stay oversold, and 08/09 shows how the market can get even more oversold!

@CalebFranzen

• Of the 26 S&P 500 lows since 1932, nine (35%) were in October and 5 (19%) in March. How can it be that only 2 months account for more than half of the lows? That’s no random walk, is it? My guess is that it has to do with earnings expectations which are often reset in October (after Q3 results) and/or March (after year-end). But, interestingly, a casual survey reveals that 15 of the 20 declines in Fed funds rates between 1957 and 2019 occurred either in the fall (10) or in the spring (5). The current consensus is for the dovish Fed to return next spring.

@AriWald via @SamRo

Two Putin allies ridicule Russia’s war machine in public

The withdrawal of Russian forces from a strategically important town in eastern Ukraine has prompted two powerful allies of President Vladimir Putin to do something rare in modern Russia: publicly ridicule the war machine’s top brass.

Russia’s loss of the bastion of Lyman, which puts western parts of Luhansk region under threat, touched a nerve for Ramzan Kadyrov, the leader of the southern Russian republic of Chechnya.

[Kadyrov] suggested that Russia should consider using a small tactical nuclear weapon in Ukraine in response to the loss. (…)

Such public contempt for the generals running Russia’s war is significant because it indicates the level of frustration within Putin’s elite over the conduct of the war while also piercing the Kremlin’s carefully controlled narrative. (…)

Brazil’s Leftist Former President Wins First Round of Election The result means current President Jair Bolsonaro and Luiz Inácio Lula da Silva, who served two terms but was jailed on a corruption charge, will face each other in an Oct. 30 runoff.

Mr. da Silva, a standard-bearer of the Latin American left who is widely popular among the poor despite having been jailed on a corruption conviction in 2018, clinched 48.2% of the vote. The tally was just shy of the majority he needed to win outright, with 99.1% of votes counted Sunday night, according to Brazil’s electoral court.

Brazil’s right-wing leader notched 43.4% of the vote, nearly 51 million and far more than the 36%-37% support that polls from Datafolha and Ipec said that the ex-army captain would garner. Allies of Mr. Bolsonaro also swept to victory in an election that included votes for members of congress and state governors. (…)

A victory by Mr. da Silva in Brazil, home to 215 million people, would mean that every major country in South America, from Argentina to Venezuela, would be led by a leftist government. (…)

Iran Protesters Circumvent Internet Disruptions They are finding new ways to challenge the Islamic Republic after the government imposed sweeping disruptions to the internet that have affected the movement’s ability to use social media to spread its message.

(…) Some activists are trying to skirt internet disruptions that started almost two weeks ago by using secure connections, such as virtual-private networks, say residents in Tehran. These people say they are turning to Farsi-speaking satellite broadcasts such as London-based Iran International, which publishes footage of the protests and provides updates on planned demonstrations.

(…) in private, some officials have shown understanding for the protesters’ grievances over Ms. Amini’s death. “But the government is stuck,” said an Iranian official. “It has made the veil a foundation of the system so it can’t backtrack.”

• Khamenei Slams Protests as Security Forces Target Universities University campuses were a critical driver of the 1979 revolution and students formed a core part of opposition groups that toppled the Shah of Iran. The Islamic Republic has always heavily controlled and suppressed political activity at universities.